The UK regulator’s clampdown on Binance, one of the world’s largest cryptocurrency exchanges, offers a reminder to consumers around the world that they will struggle to retrieve any of their money stashed in these new assets if something goes wrong.
So far, this message has not cut through. Fewer than one in 10 potential buyers of cryptocurrencies have seen official warnings about crypto, according to Financial Conduct Authority research this month, and about 15 per cent of crypto holders incorrectly believed they had some financial safety net.
Why are no protections in place?
The pace of development in the crypto industry has far outstripped regulators’ ability to respond. Most financial rules in the past decade stemmed from the 2008 crisis, when bitcoin was a hobby for a small band of enthusiasts.
Efforts to catch up are complicated by a fundamental question: what is crypto? It does not easily slot into the existing regulatory framework, which clearly delineates equities from futures, commodities from bonds and currencies.
“When it comes to consumer protections, the quick answer is there aren’t any. Regulators and policymakers are still struggling to define what it is,” said Anthony Morrow, chief executive of financial advice service OpenMoney.
In the UK, crypto is not covered by the Financial Services Compensation Scheme — the deposit insurance scheme that can compensate consumers for up to £85,000 of losses.
Similarly in Europe, most crypto assets fall outside EU financial services legislation, and outside investor protection rules.
Cryptocurrency brokerages in the US are licensed as Money Transmitters, rather than as investment institutions, and so investors are not covered by consumer protections such as the Federal Deposit Insurance Corporation.
Are companies in this space really not regulated?
They are, but those regulations are limited. In Switzerland, which has sought to encourage the development of the industry, cryptocurrency exchanges are legal if they secure a licence and meet rules around financial crime.
The US Securities and Exchange Commission, the biggest markets regulator, has said cryptocurrencies such as bitcoin are not securities and therefore do not fall under its jurisdiction. This could change as politicians and watchdogs worry about the risks to investors and savers.
In the UK, companies that provide crypto trading or custody have to register with the regulator for anti-money laundering oversight. More than 50 companies have withdrawn applications with the FCA to operate registered cryptocurrency businesses in Britain after the watchdog pushed back over low standards.
“Even if a crypto asset business is registered with us, we’re not responsible for making sure that they protect your assets,” the FCA said.
Where regulators have the authority to act, they have shown a willingness to do so. The FCA has banned the sale of regulated crypto-based derivatives and other products to retail customers due to concerns over the high risk of consumer losses.
What happens if a regulator bans my brokerage?
For UK crypto enthusiasts, the FCA’s Binance decision may feel more symbolic than prohibitive. Consumers can still access Binance.com, although they will be met with a warning that the exchange is not allowed to conduct regulated business in the UK. Only 4 per cent of British crypto customers use a UK exchange, according to the FCA.
The UK regulator publishes a list of companies that it thinks are offering crypto services without permission, and recommends that customers do not do business with them.
US-based investors are barred from buying digital assets unless the companies offering them are registered with the Commodity Futures Trading Commission, and are prohibited from investing on Binance. However, regulators have said some investors use geoblockers to skirt these restrictions.
What if my crypto password is lost or stolen?
Crypto owners are responsible for looking after their unique “private keys”, which operate like passwords and allow users to buy and sell crypto assets. If you lose your private key, there is no way to recover it, so the cryptocurrency holding is lost for ever.
Even the most regulated exchanges, such as Coinbase, do not cover investors who lose their password. Chainalysis estimates 20 per cent of the supply of bitcoins has been lost in this way.
Exchanges also offer limited protection if someone else gains access to your account and steals the asset. The digital database that holds the record of all deals is so widely distributed it is impossible to unwind a transaction and restore your funds — unlike in the case of credit card fraud. That complexity is part of the design of the asset.
“It can be impossible to recover the funds, which I have not seen in other assets. Except shipwrecks,” said Burr Eckstut, a cryptocurrency specialist at Covington, the London law firm.
What if my exchange or broker fails?
Traditional financial markets provide clear distinctions between exchanges, where deals are done, and brokers, which do the deals on your behalf.
In crypto markets the roles are far more fluid. Exchanges can be a trading venue and also hold the assets in custody. They may also hold the vital “private key”, which enables owners to buy and sell their assets. That creates a single point of risk for an investor.
But if one of these platforms runs into financial difficulty, if it is hacked, or IT systems fail or even collapse, it may take a long time to get assets back, if ever. Again, that is because many service providers sit outside protections offered by government-backed deposit insurance schemes.
What happens if I am the victim of financial fraud?
This falls under law enforcement in most countries. The police investigate cybercrimes, and the links between crypto and illicit activity, but their ability to recover stolen cryptocurrencies can be limited.